How to Analyze a Short-Term Rental Property for the Highest Possible Profit

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This is an excerpt from Short-Term Rental, Long-Term Wealth by Avery Carl. Order the book today!

As investors, we have been indoctrinated to believe that if a property has hit the MLS it’s not a good investment. Many more traditional investors think that the wholesalers pick off any real deals, and if a property makes it past the wholesalers, then the listing agent will send it out to all of their investors, who will gobble it up if it has any value. This is not as true with STR properties as it is with traditional long-term investment properties.

For example, in metro markets, it’s becoming more common for STR-eligible properties to be purpose-built new construction, which is going to be listed at the highest possible value with every dollar squeezed out of each one. In vacation markets, it’s very difficult for the wholesaler model to work. Think about it: In a market where the majority of the properties being bought and sold are either true vacation homes or vacation rentals, if a seller starts to get into financial trouble, they will unload those properties at retail prices well before they become “distressed,” or before the seller has to accept any deep discounts on them. This is especially true of hot vacation rental markets where property values have appreciated significantly over the past decade.

Additionally, the idea that any decent property will be gobbled up by real estate agents’ investor lists is also a bit of a stretch. I have been an agent for years now, so I am going to take a liberty and make this statement: Many agents are dumb and/or lazy. In the case of real estate agents, the 98/2 rule applies. What I’m getting at is that only a handful of agents in any given market are going to know what an investor list is, even fewer are going to have one, and even fewer are going to be proactive enough to use it for marketing. This, ladies and gentlemen, is why profitable STR properties make it to the MLS every day.

Still, it is possible to find off-market deals for STRs. One way is through local STR and real estate investing groups and their associated social media pages. Your choice of agent will also determine how much access you have to any off-market properties. You’ve already learned how to find and interview great agents. Use those tools to find one of the 2 percent of agents doing 98 percent of the work, and through them you will find any off-market deals available. An agent who does hundreds of deals with dozens of other agents a year is going to have the most connections and the greatest access to any premarket listings. But remember, off-market STRs are more like a dripping sink than a fountain. There will be an unsteady trickle of one or two at a time, and you’ll have to act on them before they head down the drain. You’ll need to be ready to analyze fast and pounce if you come across one. Often, the value of an off-market STR deal lies not in its being priced lower than its MLS counterparts. The real value of an off-market STR deal is the removal of the competition that comes with MLS properties.

Recently, the NAR passed a new policy called Clear Cooperation. This rule was enacted to give every agent access to every deal on the MLS, rather than having deals go only to the top-producing agents. Under this policy, all real estate agents have to post properties as active on the MLS within one business day, or forty-eight hours (whichever is shorter), of publicly marketing the property. The NAR defines “public marketing” as any email or communication about the property to anyone outside their own office. This regulation has impacted many agents’ ability to provide off-market opportunities to their clients for any significant period of time, and is something that we, as investors, need to be aware of. Some MLS boards have forms for sellers to sign that allow their agents to keep the property off-market for longer than the allotted one business day or forty-eight hours, but many do not. Unfortunately for agents who do a lot of investor deals, we now have a limited amount of time to discuss off-market opportunities with our clients, so keep that in mind during your property search. If a property is off-market, you’ll have to move fast!

Size does matter

Properties have different ROIs depending on size. As a general rule, properties with four bedrooms or more have higher ROIs and overall management efficiencies than their one- to three-bedroom counterparts. For example, I own 2 two-bedroom properties and 2 four-bedroom properties in the same market. My gross annual income on the four-bedroom properties is just over double the gross annual income on the two-bedrooms, but the expenses on the four-bedrooms are not double the expenses on the two-bedrooms. The expenses on the four-bedrooms are only about 15 percent higher than the expenses on the two-bedrooms, so my ROI on the four-bedrooms is significantly higher. Does that make my two-bedroom properties bad investments? No, it just makes the four-bedroom properties better.

While larger properties do have higher ROIs, if you only have enough capital for a smaller property, go ahead and pull that trigger to start generating some cash flow. In the amount of time it takes to accumulate a larger down payment for a larger property, prices may have risen so much that you miss other opportunities while saving.

Don’t reinvent the wheel

There are numerous Airbnb “gurus” out there who will charge you an arm and a leg to tell you to spend an extra $50,000 on your vacation rental in order to “set it apart” to maximize income. I can always tell when a client has been through one of these guru courses because they usually have some outrageous suggestions on what they should do with the property in order to maximize cash flow.

In one instance, we were standing in a new-construction log cabin with custom fixtures, furniture, everything. It even had a putting green room already installed. The client then asked me if I had a contractor who could add “port holes” to the wall separating the putting green room and the game room. I asked him what he meant, and he said, “You know, port holes, like a cruise ship. And maybe a ball pit in this corner, and an indoor slide over there. And we will rip this floor out and put in a floor of pillows. It’ll rent like crazy!”

A custom five-bedroom cabin with a view of the Great Smoky Mountains will rent like crazy the way it is, without going through all that time and expense. I asked him why he wanted to cut holes in brand-new, freshly stained Alpine log walls. “Oh, I went to Guru X’s course, and he said you have to really set yourself apart. He has clients with full Star Wars–themed houses!” The client paid several thousand dollars for this person to tell him he needed to turn a beautiful cabin in the Great Smoky Mountains into a McDonald’s PlayPlace in order to maximize ROI. Tourists come to the Great Smoky Mountains to rent cabins in the Great Smoky Mountains.

The point being: All you have to do is select a property that embodies the general expectation of tourists in the market. When tourists visit mountain areas, they just want a cabin. When tourists visit beach markets, they just want a nice condo or beach house. It is very easy to get caught up in over-improvements. Going too crazy with a community of tiny homes or tree houses or glamping structures (or whatever type of alternative property is featured on HGTV right now) treads a very fine line between a vanity project and an investment.

Speaking of which, the tiny homes, tree houses, glamping structures, and shipping container houses are all the rage, but I have yet to see anyone successfully execute these ideas. Even if they did, it would take a lot more time and resources than simply buying a property that fits the expectations of the market. You’re an investor—just make the investment. There are no prizes for creativity, which brings me to my next point.

Keep your emotions out of it

Keeping your emotions out of LTR investments is easy. Keeping your emotions out of STR investments is harder. Why? Because they’re fun. If you’re searching in a beach or mountain market, you start picturing your family vacationing or spending holidays in the property. Do your absolute best to keep thoughts like this at bay. As soon as you allow your emotions—and, in turn, your personal preferences—to creep into your decision-making, rather than just focusing on what rents the best, your ROI decreases before you even make the offer. It comes down to the basic rule of keeping business and pleasure separate. If you try to combine the two, your income will suffer because you’ll want to use the property for your own purposes. Keep your investor mindset and analysis—not your desire to impress your friends with your cool beach house—at the forefront when making investment decisions.

Gross means gross

STR investors have different opinions of what “gross income” means or should include when quoting rental history. Many will say gross should include only price per night, disregarding cleaning fees or taxes. Some say that gross should include taxes but not cleaning fees. I call these numbers “hybrid gross” numbers. So what’s the right answer? “Gross” means “all monies coming in.” Therefore, in my opinion, cleaning fees should always be included in gross numbers because there is income built into the cleaning fees. I call these “true gross” numbers. Many STR investors charge their guests a significantly higher cleaning fee than what they are charged by their housekeepers. For example, a housekeeper charges $100 per cleaning, the owner charges a $150 cleaning fee to the guests, and the property is cleaned an average of five times per month. That extra $50 per cleaning adds up to $3,000 in income per year. Why is that $3,000 not allowed to count toward gross income? Those who believe it shouldn’t count are missing out on a significant piece of income.

Another reason why true gross, and not hybrid gross, needs to be quoted is that most online booking platforms send homeowners a 1099 at the end of the year. These 1099s are based on true gross income. In other words, when analyzing an STR, it’s important to know the true gross income and not hybrid gross income, because Uncle Sam is going to expect his cut of the true gross, not hybrid gross, at the end of the year.

To learn more about analyzing, buying, and managing vacation properties, check out Short-Term Rental, Long-Term Wealth by Avery Carl today!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.